James Pethokoukis

Politics and policy from inside Washington

Harvard study: Obama stimulus should have focused more on tax cuts

Oct 28, 2009 18:48 UTC

Now they tell us. A new NBER paper from Harvard’s Alberto F. Alesina and Silvia Ardagna (“Large Changes in Fiscal Policy: Taxes Versus Spending”) makes the case for tax cuts over spending as stimulus:

As we well know a very large portion of the current astronomical 12 percent of GDP deficit is the result of bailout of various types of the financial sector.  … But part of the deficit is the result of the stimulus package that was passed to lift the economy out of the recession. About two third of this fiscal package is constituted by increases in spending, including public investment, transfers and government consumption. According to our results fiscal stimuli based upon tax cut are much more likely to be growth enhancing than those on the spending side. In this respect the US stimulus plan seems too much based upon spending.

Needless to say when considering a single episode many other factors jump to mind, factors which are difficult to capture in a multi country regressions. For instance, American families were saving too little before the crisis. An income tax cut might have just simply been saved and might have had not a big impact on aggregate consumption. However, more saving might have reinforced the financial sector, think of the credit card crisis for instance. In addition, one could have though of tax cuts that stimulate investment. Also, given the gravity of the crisis an increase in the generosity of unemployed benefits seems quite warranted both in terms of social justice and in terms of sustaining aggregate demand, since the unemployed probably save very little anyway. The benefit of infrastructure projects which have “long and variable lags” is much more questionable.

COMMENT

Drewbie,I have to admit that I’m by no means an economic expert. I do however see the flow of money from citizens that actually make up the economic engine, to merchants who’s sole purpose is profit extraction.If there were real value in what is being “produced” today then there would be no need to drive debt the way we have. We were encouraged by corporate america and also by government (because of business sector lobbying), to spend money we didn’t have, to buy things we didn’t need. We were given the blessing by the powers that be to support our country’s economic growth by way of consumption.But when this experiment failed, as it was bound to, those who are supposed to represent OUR (the citizen’s) interests, instead jumped to the aid of the business/banking sector (remember the too big to fail bs?), by giving them money to stay in business.It was money that should have gone to help citizens stay afloat while the business sector was shaped by the “survival of the fittest” philosophy they touted so loudly in the 80′s and 90′s.Instead they magically convinced our elected representatives that making sure THEY stayed in business was the only way for us poor folks to be properly served. As soon as they realized that we were focusing on paying down our own debts, we stopped getting any more “stimulus” checks.By the logic displayed in the actions of our country over the past few years, it’s easy to see that our system REQUIRES that a percentage of the population go homeless, hungry,uneducated, and sick. Otherwise there is no opportunity for profit.Even though the citizenry is too IMPORTANT to fail, our “representatives” did not serve our interests. They served their own interests and the interests of those who bring money their way.Only one president ago we spent money hand over fist to kill people in other countries because we SUSPECTED they intended to do us harm. We fought so hard for this that even when we realized the truth we still went ahead and spent that money up, and spilled the blood of our children, at the expense of our own people here at home.But now we have issues of health care and education and all of a sudden cost is a factor. How absurd is this? If we were willing to spend money we didn’t have in order to kill, then surely we can make some economic adjustments in order to ensure access to health care and quality of life.This is not a technical issue (who’s going to pay, how are we going to do it etc..).It’s simply an ethical one. We’ve already made the choice to spend money we didn’t have in order to kill.Now we have a new question before us. Should we make the effort to ensure a better quality of life for our people here at home, or not?

VAT Attack! Another reason it is a bad idea

Oct 28, 2009 18:36 UTC

One reason many free-marketeers want to take a pass on a value-added tax is that it would only fuel bigger government via higher tax revenues. Indeed, the good folks at TaxVox find new research that helps make that case (bold is mine)”

In the most recent edition of the American Economic Review, Raj Chetty, Adam Looney, and Kory Kroft, examine the effect of tax transparency – what economists call salience – on economic efficiency.

Traditionally, economists view the structure and application of a tax as unimportant. All that matters is the change in relative prices. But Chetty, Looney, and Kroft find that structure and application do matter. For example, they find that consumers are less likely to buy an item if a sales tax is explicitly listed on the product than if the same tax is instead added at check-out.

Chetty, Looney, and Kroft’s theoretical model indeed shows that efficiency increases as a tax becomes less salient. However, their model also shows that reducing the salience of a tax will necessarily harm consumers (albeit not by as much as it helps the government). In other words, tricking consumers into thinking a tax does not exist has two effects: 1) it leads them to poor consumption choices; and 2) it increases tax revenue because more transactions are taxed. In dollar terms, the harm to consumers is less than the increase in revenues. But whether or not you view an opaque tax as a useful policy instrument depends on whether you think the gains to government coffers are worth the reductions in consumer welfare.

As Milton Friedman feared, government can go a step further. If complicated and opaque taxes can dull consumer response, they can also dull the political penalty associated with higher tax rates. An optimizing government could then increase tax rates by more than fully-informed voters would like.  Amy Finkelstein, in the most recent edition of the Quarterly Journal of Economics, finds that drivers are less aware of tolls paid electronically and that switching from toll booths to electronic tolls led to a 20 to 40 percent rate increase. In other words, as salience goes down, tax rates go up.

Me: But for Team Obama, the hidden nature of a VAT would be a feature not a bug. The same approach is being tried with a) healthcare taxes via an excise tax on health insurance companies that will be passed onto consumers, and b) cap-and-trade which is a hidden energy tax that will also be passed along. There is nothing wrong with the idea of a consumption tax as long as it a) replaces other taxes and b) is transparent, such as would be the case with the Hall-Rabusha flat consumption tax.

COMMENT

Not hard to understand, but not obvious, either.

Very enlightening.

A China reality check

Oct 28, 2009 18:26 UTC

Thomas PM Barnett makes good sense, as usual:

Japan’s rise and decline should serve as a grim warning to China right now.

Japan got old, but China will get older faster. Japan kept its environment relatively clean, China is trashing its own. Japan built its manufacturing power on excellent goods, China is fly-by-night by comparison (reading a book on that now).

In sum, China has so many huge hidden deficits incurred during its rise, that I think it will suffer future stagnation that makes Japan’s seem tame, especially since China’s political system is so brittle and unimaginative.

I guess I’m just responding to all this China-will-rule-the-world vibe connected with the 60th b-day celebration. As soon as I read stuff like that, the Irish in me says you’re heading for a fall.

COMMENT

It’s kind of sad that people have to look to China for hope. It really is a terrible land, aside the wonderous construction projects that are meant to overpower the senses and confuse us. A land that feels it needs to make monuments to power really has none… they’re growth rates are completely doctored, corruption is open and rampant, the gov’t keeps the currency pegged artificially, and the gov’t uses the military to control the citizenry. Though it is little reported here, there are numerous regions of (essentially) open revolt in China, not to mention occupied land (Tibet) which spurs more defiance from the people. So while the coast cities may seem like a beacon to the future, the rest of the country is in chaos and in big trouble. So much for the Chinese miracle… the real miracle will be if they survive a sustained downturn in the American economy.

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VAT Attack! The mysterious Christina Romer and higher taxes

Oct 28, 2009 18:21 UTC

Christina Romer’s speech on Monday had this overlooked bit, which I put into bold:

Our calculations showed that slowing the growth rate of health care costs by one and a half percentage points starting in 2014 would result in a budget deficit in 2020 that was 1 percent of GDP smaller than it otherwise would have been. By 2030, the impact is a reduction in the budget deficit of 3 percent of GDP; by 2040, it is a reduction of 6 percent of GDP.23 These estimates make vivid the notion that the number-one thing we can do to help get the long-run budget deficit under control is to slow the growth rate of health care costs.

Now, slowing the growth rate of costs will not solve all of our long-run budget problems. Our population is aging and even lowering the growth rate of health care costs quite substantially leaves them growing faster than GDP. As a result, other actions will also need to be taken. While health care reform may not be the “silver bullet,” it clearly must be a significant part of the solution to our deficit woes. It is the key step that we can take right now to bring the long-run budget problem down to manageable proportions.

Me:  What “other actions” might she be referring to? Obviously higher taxes. Indeed, earlier in the speech she references the work of economists William Gale and Alan Auberach in this Brookings report:

Even if rising health care costs are an important component of the long-term problem, they are not necessarily “the” cause of the fiscal gap. The estimated gap is increased by more than 5 percentage points of GDP just by continuation of the policies that were enacted during the Bush Administration. … It will prove difficult to close the gap entirely via modifications to existing taxes and spending programs. A new revenue source, such as a value added tax (VAT), may be needed. A VAT imposed at a rate between 15 and 20 percent would essentially close the fiscal gap under the Administration’s budget.

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